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99 Cents Is Enough

It sounds improbable, but 99 Cents Only Stores isn't cheap.

99 Cents Only Stores(NYSE:NDN)reported another fairly lackluster quarter yesterday, featuring a 24% decline in profits. True, part of that shortfall was attributed to an actuarial adjustment to a California workers' compensation reserve. On the other hand, competitor Dollar Tree Stores(NASDAQ:DLTR) managed sharply higher earnings in 2003, as Rick Munarriz pointed out in February.

For 99 Cents Only Stores, it's Houston that's got a problem. While the average non-Texas store has yearly sales of almost $4 million, stores in Houston ring up about $3 million. Management claims that as its presence grows in that city, so will average store sales. The company is making a big bet on that, opening 14 stores there in 2004 -- more than in any other city.

All told, 99 Cents Only Stores will add 25% to its square footage in 2004 as it adds 48 new stores. With net income estimated at $66 million to $71 million (and paying no dividend), the company will use all its cash flow to fund a $70 million to $80 million capital-spending plan. If it falls short, there is a rock-solid balance sheet with $146 million in cash and cash equivalents waiting as a net.

In fact, drilling down into the fourth-quarter numbers, we see that sales actually jumped 17.4%, but operating expenses were up 31.3% (over a third of that was related to workers' comp). The upshot was a sharp decrease in operating margins from 14% in the fourth quarter last year to 9.4%. Clearly, resolution of this issue -- which has also plagued Motley Fool Stock Advisor selection Costco(NASDAQ:COST), among others -- will have an immediate and positive impact on profits.

Moreover, despite the rough quarter, 99 Cents Only Stores managed gross margins of 40% vs. Dollar Tree's 36% and Wal-Mart's(NYSE:WMT) 22%. So, investors looking for better alternatives find only Family Dollar(NYSE:FDO) offering a balance sheet with no debt, but also lower gross margins at 34%. Dollar General(NYSE:DG), on the other hand, brings debt and lower gross margins. For you valuation purists, only Dollar Tree, with as much cash as debt and a price-to-earnings multiple of 19, looks cheaper by the numbers.

As it turns out, while 99 Cents Only Stores trades for a premium of 28 times forward earnings, if the company can grow to California proportions in Houston, and keep up its gross margins, 99 Cents is just about right.